The recession of 2007 to 2009 was brutal. The economy contracted by 4 percent. Unemployment peaked at 10 percent. About 8.5 million jobs were lost. It's no wonder that a year later, nearly two-thirds of Americans thought President Obama's stimulus package hadn't worked.
But a new study suggests that without the stimulus — and, more crucially, without bank bailouts and the Federal Reserve's intervention — things would have been much, much worse. Princeton economist Alan Blinder and Moody's Analytics' Mark Zandi estimate, in a paper for the Center on Budget and Policy Priorities, that without these policies:
- The recession would have lasted twice as long.
- The economy would have shrunk by nearly 14 percent, not 4 percent.
- Unemployment would have peaked at nearly 16 percent, not 10 percent.
- More than 17 million jobs would have been lost, around twice the actual number.
- In 2015, there would still be 3.6 million fewer jobs and 7.6 percent unemployment.
Government policies saved millions of jobs
Blinder and Zandi arrive at these estimates through economic modeling. Zandi and Moody's have one of the most cited private sector models of how the economy responds to changes in public policy, and regularly produce "multiplier" estimates of how much the economy would grow in response to $1 more funding for a given policy. (For example, the current paper estimates that a $1 temporary increase in food stamps at the start of 2009 would have grown the economy by $1.74.)
So Blinder and Zandi used the Moody's model to simulate how the economy would've looked if no special measures had been taken in the wake of the financial crisis and recession. They assume that the government's "automatic stabilizers" — programs like food stamps and progressive taxes that help people more when the economy's suffering — took effect, and that the Federal Reserve took interest rates down to zero. They then compared the economy in that counterfactual to the actual history.
They did better than that, though. They also modeled the contribution of each individual policy:
- The 2009 stimulus package cut unemployment by 1.4 points and increased GDP by 3.3 percent in 2010.
- The Fed's quantitative easing added 1.1 percent to GDP and cut unemployment by 0.6 points in 2012.
- The bank bailouts — specifically the TARP program and the Fed's "stress tests" — cut unemployment in 2011 by 2.2 points and increased GDP by 4.2 percent.
- The auto bailout cut unemployment by 0.4 points and increased GDP by 1 percent in 2010.
Can we trust this estimate?
It's important to keep in mind that this is an estimation based on a model. That has its advantages, and it's a valid economic technique. It's a lot easier to construct a precise counterfactual when you can use a model than it is to try to statistically isolate the effects of a given policy. But some critics have argued that these models assume the stimulus worked rather than proving it.
One reason you might want to trust Blinder and Zandi, however, is that the empirical evidence on the stimulus backs them up. I did a roundup of the best studies back in 2011 on just the fiscal side, but here are a few of the empirical findings on the 2008-'09 interventions in general:
- A study by the San Francisco Fed's Daniel Wilson, which compared stimulus spending and change in employment across states, found that the 2009 stimulus act created 2 million jobs in its first year, and 3.4 million by March 2011.
- A paper by Gabriel Chodorow-Reich, Laura Feiveson, Zachary Liscow, and William Gui Woolston estimated that Medicaid funding in the stimulus added years of employments, with each $100,000 securing 3.8 job-years.
- Dartmouth economists James Feyrer and Bruce Sacerdote compared state-level spending and found that the 2009 stimulus act created millions of jobs at a cost of $100 to $400,000 each; they found that education spending was ineffective as stimulus, but giving money to low-income people was very effective.
- A paper by Arvind Krishnamurthy and Annette Vissing-Jorgensen found that quantitative easing was effective in lowering interest rates and making it cheaper for companies to borrow and thus hire.
- University of South Carolina's Allen Berger and Raluca Roman found that TARP bailouts to banks with local markets were correlated with increase in job creation in those markets.
The empirical evidence suggests these policies worked — which provides some basis to trust modeling estimates of the effects. What's more, a 2014 poll of eminent economists found that 37 thought the 2009 stimulus lowered the unemployment rate, and only one disagreed.
The counterfactuals this paper doesn't consider
Blinder and Zandi are fairly compelling in arguing that the policies chosen by the Bush/Obama administration, Congress, and the Federal Reserve led to a shallower recession and quicker recovery that we would've had otherwise. But it's doubtful that any administration would have done literally nothing. And there's a wide array of alternative policies that at least potentially could have bested the ones chosen:
- Obama's chief economist, Christina Romer, recommended a $1.7 to $1.8 trillion economic stimulus package, rather than the $832 billion the 2009 stimulus wound up costing. A much larger bill quite possibly would have ended the recession even sooner.
- Scott Sumner and other economists argue that the Fed could have taken more extreme measures in 2007-'08, such as adopting an NGDP target or negative interest rates or a higher inflation target, effectively printing more money and ending the recession sooner without any need for congressional intervention.
- A number of economists, including Atif Mian and Amir Sufi, Glenn Hubbard and Christopher Mayer, and Martin Feldstein, proposed direct intervention to help homeowners, either through enabling mass refinancing or through using government funds to pay down principals.
- In lieu of a bailout, University of Chicago's Luigi Zingales proposed forcing banks' creditors to accept equity in exchange for forgiving the debts the banks owed.
- When Sweden had a financial crisis in the early 1990s, it nationalized the banks temporarily. The US could have done that, and policymakers in the Obama administration actually considered it.
- Iceland didn't bail out its banks in 2008-'09. Instead, it let them fail, devalued its currency dramatically, and imposed capital controls to keep money from fleeing the country. It basically worked. That's an easier approach for a small country, but the US could have tried an adapted version.
So Blinder and Zandi can tell us that the policy response was better than nothing. "If my only options are what actually happened — even including the resulting moral hazard — and the Blinder-Zandi scenario, then bail, bail, bail, stimulate, stimulate, stimulate," as AEI's Jim Pethokoukis writes.
But that doesn't mean what happened was the best possible policy response. Maybe we could have done better.